The landscape of private equity investment has traditionally been dominated by fund-based models. However, in recent years, a deal-by-deal approach has emerged as a viable and increasingly accepted alternative. This article examines the trajectory of Duke Street, a prominent UK mid-market private equity firm, as it navigated both fundraising challenges and opportunities through a strategic shift to deal-by-deal investing.
In 2012, Duke Street made headlines when it opted for a deal-by-deal strategy after halting its efforts to raise an €850m fund. This decision sparked considerable debate within the private equity sector. Some observers questioned the stability of the private equity model itself, while others speculated about Duke Street’s performance. Despite the initial uncertainty, Duke Street moved forward, demonstrating resilience and adaptability.
A significant milestone in Duke Street’s deal-by-deal journey was the partnership established with Paris-based investment firm Tikehau Group in June 2013. Peter Taylor, managing partner at Duke Street, highlighted the initial skepticism surrounding the deal-by-deal model, particularly in Europe. Tikehau’s acquisition of a 35% stake provided Duke Street with crucial underwriting capability, lending credibility to their innovative approach.
The acquisition of Voyage Care from HgCapital, a transaction valued at £375m, further solidified Duke Street’s position and quelled doubts about their new strategy. Taylor noted that completing such a substantial deal outside of a conventional fund structure addressed many of the lingering questions. Since then, Duke Street has successfully executed five deals using the deal-by-deal model. This track record has fostered greater acceptance among investors, with increasing interest from US Limited Partners (LPs) who are more familiar with this investment approach. The growing prevalence of LP co-investments also complements the deal-by-deal framework, creating a more collaborative investment environment.
Conversely, Lonsdale Capital offers an interesting point of comparison. Having initially operated on a deal-by-deal basis for six years, Lonsdale Capital recently transitioned to a fund-based model, closing a £110m fund. Alan Dargan, a founder of Lonsdale, explained that while they would have preferred to launch a fund from the outset, the hesitancy of LPs towards debut funds led them to first establish a strong track record through deal-by-deal investing. David Gasparro, another founder, emphasized the importance of building credibility and establishing relationships within the advisory community during their early years.
Gasparro echoed Taylor’s observation about the diminishing skepticism towards deal-by-deal investing. However, for Lonsdale, the primary advantage of shifting to a fund structure was the enhanced certainty and reduced administrative burden associated with raising capital for each individual deal. Furthermore, the fund structure has positively impacted recruitment at Lonsdale. Dargan noted that a fund provides a more stable environment, enabling them to attract talent and implement long-term investment strategies.
Interestingly, both Duke Street and Lonsdale observed behavioral shifts within their teams as a result of their respective approaches. Duke Street found that the deal-by-deal model fostered a more entrepreneurial and driven culture. Taylor explained that the direct link between deal success and team compensation, with faster payouts compared to traditional fund structures, created a stronger sense of ownership and motivation. While emphasizing it’s not purely “eat what you kill,” the model has undeniably fostered a hungrier and more engaged team.
In contrast, Lonsdale did not perceive a significant change in team behavior after transitioning to a fund. Gasparro suggested that their carry structure, where all employees have invested in the fund, already provided a strong incentive, similar to the deal-by-deal model. However, Dargan acknowledged the faster economic benefits of deal-by-deal investing, particularly for successful exits, which were more immediately realized under that model.
A key development that has benefited Duke Street’s deal-by-deal strategy is the increasing appetite for co-investments among LPs. James Almond, partner at Duke Street responsible for fundraising, highlighted that deal-by-deal investing is more cost-effective for LPs and grants them greater control over investment decisions, allowing for deeper engagement during due diligence and ownership. Duke Street has structured its co-investment program as a club, accommodating LPs with varying preferences for early or later-stage involvement in deals.
Taylor acknowledged that their approach to deal-by-deal and co-investment is continuously evolving alongside the changing LP landscape. Initially, fund-of-funds were restricted from participating due to fee and carry structures. However, as their own strategies evolved, they have returned to Duke Street, indicating a broader shift in investor preferences and capabilities.
Lonsdale’s focus on the smaller end of the market presents a different dynamic regarding co-investment. Gasparro argued that for smaller deals, a fund structure is more appealing to LPs as it streamlines administration. Dargan added that LP commitments into their fund, typically £10m or more, are better suited for fund deployment in the small-cap market rather than individual deals. The fund structure provides investors with exposure to a diversified portfolio of smaller, specialized market opportunities.
In conclusion, Duke Street and Lonsdale Capital offer valuable case studies in contrasting approaches to private equity investing. While Lonsdale leveraged deal-by-deal to establish its track record before transitioning to a fund better suited for its small-cap focus, Duke Street successfully embraced deal-by-deal, capitalizing on evolving LP preferences and co-investment trends. Duke Street’s pioneering adoption of the deal-by-deal model, initially met with skepticism, has ultimately positioned them advantageously within a changing private equity landscape, demonstrating the adaptability and innovation within the industry.
